The cautionary tale of India versus China

Hong Kong-based utility CLP Holdings has almost completed a new coal-fired power plant in Haryana, the Indian state neighbouring Delhi.
In India, as in China, CLP is the largest foreign investor in power projects.
Because CLP is not actually Chinese, it is agnostic when it scours the world in search of the best equipment for its plants. Yet today, wherever CLP builds - whether in India, south-east Asia or farther afield - the power-generation equipment it installs in its USD 1bn-plus plants comes from China. In other words, power equipment has become yet another manufacturing citadel that Chinese makers have successfully stormed in their move up the value-added chain.
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The success of Chinese power equipment in the Indian market offers a cautionary tale of the relative strengths of both economies. The interest rate cut in China last week - amid plummeting demand for credit, disappointing industrial production numbers and a slowing rate of increase in retail sales - suggests that Chinese growth is slowing dramatically.
Yet the example of CLP suggests that fears about China may be overdone. So even while Chinese export volumes remain uneven and rising costs force exporters to move to cheaper production sites offshore, China retains an advantage in making costlier more complicated equipment such as turbines.
However, India should not lag so far behind as it has improved its exporting might for the past two years far more than generally recognised.
Exports have grown faster than GDP and account for 25% of its economy - a higher dependency ratio than China's. Moreover, the greatest improvement has not been in services but in manufactured goods, as Jahangir Aziz, an economist with JPMorgan notes.
In addition, the composition of its merchandise exports has also shifted with the biggest improvement in engineered goods, such as cars, car parts and capital goods, reflecting India's depth of engineering talent. And finally, currency moves have given the country a huge boost in competitiveness - at least theoretically. Since August when the slide in the rupee began, the Indian currency has depreciated 27% against the renminbi.
All this comes at a time when India needs export revenues more than ever, in the face of a current account deficit that, at 10.2% of GDP, is becoming unsustainable.
Yet the CLP case shows that China is so far ahead in value-added heavy manufacturing that India may never come close to closing the gap.
It is not only the well-known tale of how China managed to put its own infrastructure act together by "pre-investing well ahead of demand", as Andrew Brandler, the chief executive of CLP, says. It is that China has taken advantage of the huge economies of scale that stem from its large domestic market to build world-class power equipment makers and take them to the rest of the region.
China's three big makers, DongFang, Harbin Electric and Shanghai Electric, can now provide equipment to the Haryana plant at almost half the price of either Indian or international manufacturers, even taking into account the cost of transportation and any tariffs on imports. Moreover, when the Chinese bid for supply contracts, they offer fixed prices whereas Indian groups offer quotes on a cost-plus basis, leaving their potential customers with the kind of uncertainty they hate. Speed is also a factor. The Chinese can deliver the turbines for the Haryana plant, a 1,320MW behemoth, in 36 months, whereas the Indians will take 60 months.
Mr Brandler believes the only way that any international group can compete is to replicate the Chinese economies of scale. That is exactly what Matsushita concluded in consumer electronics a generation ago. This was when China first started to produce items such as microwave ovens, which were almost as good quality as those Matsushita made in Japan but far cheaper.
Of course, the Chinese model is all about at least a partial suppression of market forces. Part of the attraction of ordering equipment from China is the subsidised financing that comes with those orders. But India isn't exactly a free market. Indeed, the partial reforms of India, which the private sector is constantly coming up against, represent an obstacle course that forces foreign investors to demand a higher rate of return to compensate for the risk.
Meanwhile, the cost of capital in India continues to rise. Companies can earn 9% on their deposits in Indian banks - one reason that investment is likely to continue to drop. The contrast with China, which just lowered rates, gets starker by the day.
Henny Sender is the FT's chief international finance correspondent.